PSST vs. the Aggregate Production Function
By Arnold Kling
Regular readers know that I am trying to nudge them toward a different paradigm in macroeconomics. I want to get away from thinking of economic activity as spending, and instead move toward thinking of it as patterns of sustainable specialization and trade. Even if there is only a small chance that this alternative paradigm is useful, I think it is a worthwhile exercise.
One reason for wanting to change the paradigm is that I believe that trying to describe economic activity using an aggregate production function is a mistake. When I use the derisive expression GDP factory, I am referring to the aggregate production function.
The advantage of the aggregate production function is that, when combined with a sticky nominal wage, it yields an aggregate supply curve. This allows macro to be presented using the familiar tools of supply and demand. My problem is that I think that the GDP factory is a bogus story that obscures rather than enlightens.
Instead, I think that the right tools to use for macro are the two-country, two-good models of international trade. The “two countries” could be two sectors within an economy. The agricultural sector and the urban sector. The housing sector and the non-housing sector. And, of course, there are many more than two sectors. But just talking about two sectors is a big improvement over the GDP factory.
At full employment, both countries are taking advantage of specialization and trading with one another. When something happens to adversely affect the pattern of trade, some workers shift from market activities to non-market activities, mostly in the form of involuntary unemployment. Gradually, new patterns of specialization and trade emerge, and full employment returns. That is what I have been calling the Recalculation Story.
Austrians want to focus on changes in the capital intensity (or “roundaboutness”) or production as the typical (only?) shock that can affect the pattern of trade. I will grant that in practice this can be important, but I do not wish to make it the central issue.
More comments below.1. The conventional “spending” paradigm (which includes both monetarist and Keynesian versions of AS-AD) says that output is “lost” during a recession. That is what is meant by a term like GDP gap, the shortfall of GDP from the level it would be at full employment. (Yet people sometimes speak of under-consumption. We under-consume, and yet there is a shortfall in production. Strange, no?)
I want to suggest that the output that is “lost” is output that people do not want. In 2008 and 2009, Americans do not want 2 million houses to be built. So I do not think that it is right to speak of a shortfall in output. Instead, we should say that the people who were building houses have not found a pattern of trade in which they can produce something that people want.
2. I think that technological change can drive the marginal product of many workers close to zero (When I mention ZMP, I always feel I owe Tyler Cowen a footnote.) I suspect that this happened in agriculture in the U.S. in the late 1920’s and early 1930’s, dumping a lot of manual laborers into unemployment. I suspect that it has happened in recent years because of the Internet. The Internet has created many new white-collar occupations, but by the same token even more white-collar workers have seen their marginal product fall to zero.
Eventually, the mix of workers changes, mostly due to older vintages dying off and newer vintages appearing. New trading patterns develop, we see a decline in the number of workers with low marginal product, full employment is restored, and productivity and earnings are much higher than before.
3. I wonder if the real public policy issue is not restoring full employment but coming up with a fair distribution of leisure. That is because with high levels of productivity, it is arithmetically possible to sustain a high ratio of dependents to workers. However, this is not easy to come to terms with politically. The dependents may suffer from low self-esteem. The workers may feel resentment.
I would expect that advances in productivity will increase leisure. One could argue that this is already happening. Actual retirement ages (as opposed to statutory ones) are falling, even as longevity is increasing. (I am speaking of the dominant trend, notwithstanding whatever brief disruption might have been caused by the financial crisis.) The age at which young people are expected to “settle” into adult life styles is rising. Even for people with “regular” employment, there are many jobs that include a large leisure component, including surfing the Internet and chatting up co-workers.
It could be that when the unemployment rate falls back closer to 5 percent, what we will have is a distribution of leisure that makes people happier. More young people will be experimenting with their lives (traveling, changing fields, trying to start businesses), more people will be retiring early, and only in between will most people by working at normal jobs.